Back in 2007 one could take some pride in being an economist. There were a set of truths that were pretty widely accepted, at least among the more elite macroeconomists. Now that entire edifice seems to have gone up in smoke, and I’m not entirely sure why. This will be a very long post, as I’ll try to document just a few of the truths we used to accept, which have been recently tossed aside.

1. “Monetary policy can be highly effective in reviving a weak economy even if short-term interest rates are already near zero.” The quote is from Mishkin’s text editions 1-9 (removed from 10). Friedman and Bernanke made similar statements, as did many others.

2. A much more stimulative monetary policy, perhaps involving leaving the gold standard, would have prevented the 50% fall in NGDP during the early 1930s, and thus would have largely prevented the Great Depression. Here’s Noah Smith discussing a recent survey of economists:

All of these results are interesting, but to me, the last one is huge. Milton Friedman claimed that the Fed caused the Great Depression by keeping monetary policy too tight. Ben Bernanke agreed with this view. This survey shows that most economists (or, at least, most of those surveyed; it was not a random sample of the profession) now think that Milton Friedman was utterly wrong.

3. When a central bank targets inflation, the fiscal multiplier is essentially zero. (This was the standard NK view.)

4. When AD is off target it makes absolutely no sense to say; “It’s not the central bank’s job to ‘fix’ the problem.”

5. Low interest rates do not imply easy money. (Again, Bernanke, Mishkin, Friedman, and many others made this point. It’s what we’ve been teaching our students from the number one money textbook.

7. When output and inflation both fall sharply, the economy suffers from a lack of AD. When falling output is accompanied by rising inflation, we have a real (or supply) shock.

8. Monetary policy should focus on AD, not the real return earned by savers, or the real Brazilian exchange rate, or the price of oil. Nor should monetary policy put pressure on fiscal authorities to behave better. The central bank’s job is to control AD.

9. Changes in the monetary base tell us very little about whether money is easy or tight. Keynesians obviously believe this, but even Milton Friedman made this point about the QE of the early 1930s.

10. When consumers have borrowed/spent too much, they should tighten their belts by consuming less, perhaps paying more taxes, and perhaps running a smaller trade deficit. But for God’s sake you don’t tighten you belt by having millions of consumers suddenly take multi-year “vacations.” Unemployment doesn’t help a country to work off its debt.

11. Natural disasters do not cause higher unemployment in big diversified economies, AD shocks do. This explains why Japan’s unemployment rate rose after its NGDP fell sharply in 2008-09, but did not rise at all after the tsunami.

12. Big increases in government spending, taxes, and regulation may cause harm to the economy, but don’t really play much of a role in the business cycle. They don’t cause the unemployment rate to rise in the short run, as FDR and LBJ showed.

13. Big stock market surges and crashes like 1929 and 1987 have no impact on consumption or AD or RGDP growth.

14. Capital income taxation is undesirable. The conservative side favors a flat consumption tax and the liberals favor a progressive consumption tax.

15. Chinese exchange rate policy has no impact on the US unemployment rate.

16. Internal devaluation is not a sensible way for a modern developed economy to fix a massive AD shortfall.

17. Price gouging is actually a good thing.

18. The “broken windows fallacy” really is a fallacy.

I could go on and on, but I’m getting too depressed.

Neoclassical consensus circa 2007, R.I.P.

PS. What most depresses me is that (with a few exceptions such as the minimum wage) I can’t see any facts, any empirical evidence, which would have led a reasonable economist to abandon these verities. But they did.

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Perhaps I’m missing something, but how did he jump from the survey showing that a minority of surveyed economists think that the recent recession was caused/worsened by excessively tight monetary policy to concluding that the majority refute Friedman’s assertion that tight policy caused the GD??

This makes two posts in two days where Noah (who I, admittedly, hardly find myself reading) has made some incredible leaps in logic…

2. Leaving the gold standard during the tens and twenties is what made the economy prone to deflationary collapse in the thirties. It is said that the money supply fell by around 33%. That would be virtually impossible in a gold standard, because once gold comes into existence, it tends to stay in existence. Did the government send 33% of the gold supply to the moon? No, because that 33% deflation was not gold, but fiat money. The state was already off the gold standard by the 1930s. Thus, to say that “leaving the gold standard would have helped in the 1930s” is insinuating that the prior leaving of the gold standard somehow did not exist, and that is was gold that somehow caused the deflation.

I know that Brad DeLong once believed that, but I haven’t seen him say so lately.

But, more broadly, I remember a conversation in 2009 with my local banker, and telling him that I’d never seen anything like the level of disagreement prevalent among professional economists I read, on basics then, at any other time.

It’s actually quite common that in times of crisis, people abandon the “common knowledge” of previous days. The reason is that many adopt their beliefs not out of some kind of intellectual conviction. They simply go with the mainstream without thinking anything through. Comes a challenge that required fitting surprise data into the mainstream model, they toss the model.

Example: mainstream intellectuals supported left wing ideals in Europe until 1989, and quite a few were positively apologetic to Soviet policies. Then post 1989, almost like one man (woman) all these people dumped left wing ideology once the Wall fell. But neoliberalism (as it was then called) was also adopted more like a default post 1989, not out of conviction that it represented some kind of underlying truth. So come the next crisis and you find all the same people now asking once more for a bigger role of The State (European parlance) / The Government (US parlance), etc.

Very few people actually know why they believe things. And they change their minds not “because the facts change”, a la Lord Kelvin, but because the wind changes. That includes academics.

I think we need to be careful about aggregation here. Borrowing needs a lender too. If debt is “too high”, that means that some people have spent too much and other people have spent too little.”

Stir up a hornet’s nest? I don’t believe Scott, Nick, & most others understand how a bank works. If people do the accounting correct for a bank or something bank-like, for every [something], there is not [something else].

If low interest rates do not imply easy money, could it be due to the fact that there’s a monopoly on credit creation in the United States and elsewhere? Even at ridiculously low rates each new loan will (eventually) still pull more money out of the economy than it put in.

14. Capital income taxation is undesirable. The conservative side favors a flat consumption tax and the liberals favor a progressive consumption tax.

Can someone enlighten me as to why income on unearned revenue is any more undesirable than income on earned revenue? In the grand sense, the economy is the dispatch of two resources: labor and capital. By taxing one more than the other, wouldn’t we be pushing the actual dispatch of those resources away from the efficient frontier? For the life of me, I can’t grasp why the issue of deadweight loss wouldn’t apply to this market inefficiency the same way that it applies to others.

In English: Right now, Netflix needed to increase their production capacity, they would make a choice between hiring additional labor or buying a newer/larger machine. The price of that considered labor would be not only the unmolested market value of that labor but also a variety of payroll taxes, soon-to-be mandated ACA benefits, and a share of the income taxes that the employee must suffer via tax incidence. On the other hand, if they were to buy a machine, they would simply raise the capital by selling stock, for which the only tax drag is the incidence from capital gains rates. Needless to say, the latter pales in comparison to the former.

Brian: you’ve constructed a fake margin. We don’t have a choice between “more labor” and “more capital”. We face a choice between “more consumption now” and “more consumption later”. Taxation of capital gains and taxation of capital income causes the latter to be taxed at a higher rate than the former, creating the deadweight loss.

I would say I agree with about 1/3 disagree with 1/3 and am still uncertain of the rest. I don’t think my opinion has particularly changed on most of the 18. But, I am aslo not necessarily representative of mainstream economic thinking. I don’t think my opinion has particularly changed on most of the 18.

“Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one.” – Charles MacKay, author of “Memoirs of Extraordinary Popular Delusions and the Madness of Crowds (1852)

You’re saying that most economists now believe the broken window fallacy is not true and that breaking windows does increase wealth? Or are you saying that most economists believe Bastiat was right all along?

Kevin and Randy, I thought the title was my idea, but google shows it’s been used. I come up with a good one once a year, Krugman does once a week.

Nick, Good point.

Everyone, Lots of good points. No, I don’t mean to suggest that they are all 100% out of favor (far from it), but it’s surprising to see any revisionism on basic ones like broken windows, price gouging etc.

Alex, could you expand on why we don’t really have a choice between labor and capital? It seems like that choice is made every time a business runs the CBA on a machine. If the after-tax, after-interest cost of that machine is manipulated to give it a competitive advantage over labor…

I thought the standard argument is that because consumption is he narrower base, a given revenue would require a higher rate than income taxation. The higher rate implies more leisure/labor distorttion, though you get rid of the present vs. future consumption distortion.

Further, we are not setting up a taxation system from the beginning of time. Further, not all capital income comes from savings out of labor income in reality. (Did William the conqueror’s men work hard, save up, and buy their grand estates?)

Is it really always a bad idea to shift resources from private capital goods to government investment or even government consumption?

Don’t get me wrong.

I favor a digressive consumption tax. A zero bracket and then one tax rate on consumption.

But I don’t think everyone has ever bought into using progressive tax rates on consumption rather than a progressive income tax.

Some years ago, a classmate of mine (from Virginia Tech) was at Clemson. In the aftermath of some huricane that hit South Carolina, he wrote an op-ed defending price gouging.

Some other. more senior, free market economist, who was not from the area, griped that we really don’t need this sort of thing. That is, arguments in the aftermath of a hurricane that price gouging is a good thing.

I just share this story to suggest that I have always had doubts about the universality of the “price gouging is good” argument.

The rich buying bottled water to bathe while the poor die of thirst could be a real issue in some circumstances. Queing is certainly a waste of time, especially when people have plenty of clean up tasks around their homes, but the distribution arguments become a greater than usual concern.

This is a personal concern of mine, being Mayor of a Town where a hurricane might hit. To make things worse, I am mayor of James Island, with only two bridges from the mainland (and another bridge to Johns Island, which has also has another bridge to the mainland.

“PS. What most depresses me is that (with a few exceptions such as the minimum wage) I can’t see any facts, any empirical evidence, which would have led a reasonable economist to abandon these verities. But they did.”

Bill, But don’t you see that people are FAR MORE LIKELY to die if we don’t allow price gouging. Water is far more likely to be used for frivilous activities if sold cheap. Yes, the problem you discribe could occut in a free market, but is 100 times more likely to occur if you ban price gouging. And that’s ignoring supply effects, which make the case against gouging bans even stronger.

The inherited wealth issue is addressed with a one time lump sum wealth tax at the moment the consumption tax is implemented.

ThoamasH, Liberals are moving rapidly away from progressive consumption taxes, toward the bad old days of 75% MTRs on income.

The rich buying bottled water to bathe while the poor die of thirst could be a real issue in some circumstances.

Posting from NY via an emergency generator, in an area where there are indeed water problems…

1) Under what real circumstances has such a thing as “the rich buying bottled water to bathe while the poor die of thirst” ever been something that actually happened in the real world? Examples please, of this happening in a basically free market economy/democratic polity.

Adopting policies that make real problems worse to head off fantasized problems that never occur can have toxic, mortal consequences.

2) *Even if* some rich people buy bottled water to enjoy toe baths during a drought, still the issue is what is the best policy to get more water to the drought area from elsewhere. So if the choice is between…

a) Letting the price of water rise so increased supply rushes in to meet the increased demand, being widely distributed among the populace by market interactions among the vast majority of people, but with Paris Hilton still putting up Youtube videos of her daily toe bathing; versus

b) Price fixing water so there is *no* increase in supply, and the mass shortage continues with people dying, but Paris doesn’t Youtube herself toe bathing any more — in the hope that the resulting *much smaller* supply of water will be distributed more effectively “according to individual need” than the bigger, by the same govt functionaries who have brought us the Department of Motor Vehicles and Post Office

Most people here I think would vote for (a). I hope!

IOW, “so what?” Who cares if the rich keep taking toe baths, if this is the policy that saves lives. (And, hey, in the price-fixed case why couldn’t Paris keep taking toe baths by using her wealth to buy black market water, such as from the bureaucrat distributors, if she wanted? She just wouldn’t advertise it on Youtube.)

BTW, FWIW, I note that while FEMA has run out of water for the stricken area, the Budweiser people are sending a million cans of water* here.

The fear that “the rich” might use their money during a crisis, and belief that this is something to be suppressed, is far more emotional than sensible.

Before I gave the example of my father using a big sheet of plywood to set up a big model train set for me when I was a kid. If that had happened as a hurricane crisis hit Florida with a huge emergency increase of demand for plywood there, and the market price of plywood tripled, as national distributors diverted plywood from NYS to Florida, *probably* my dad wouldn’t have spent the money on it for me. But he was “rich” enough to do so if he’d wanted. If he had paid that bigger price, *after* that big price increase equated supply with demand in Florida, would that have been *bad*?

OTOH, if plywood was price-fixed in Florida so it remained plentiful and cheap in NY, he certainly would have bought it for me.

When a disaster creates an emergency explosion of need for plywood in Florida, what’s the best policy? One that forces “the rich” in NY to pay a lot more for it, or one that lets “the rich” in NY still buy it cheap?
~~~

* That this is particularly easy for them because their beer is basically just water anyhow should not be held against them.

“Capital income taxation is undesirable. The conservative side favors a flat consumption tax and the liberals favor a progressive consumption tax.”

I think it’s correct for economists to point out that taxing capital offers a disincentive to invest. But that could be offset by other policies, such as Singapore style required savings accounts.

Since the very wealthy consume such a low percentage of their income, I don’t see how you can have a consumption tax as progressive as an income tax. For example if someone spends 10% of their income, then it would take a 100% consumption tax to offset a 10% income tax. So I’d keep the income tax including on capital, but have very large IRA annual contribution limits (say $50K) and have a mandatory 15% 401k contribution. Then you’d basically have an income tax for the rich and a consumption tax for everyone else.

This assumes such people are truly unemployed, which includes a presumption of their being in the labor force. If, however, the only reason they remain in the labor force is to receive UI and otherwise would leave it, then extended UI is a form of welfare for discouraged workers.

The merits of choosing such welfare in preference to other forms of stimulus are debatable, but it is no disincentive to those who would have insufficient incentive even without it.

By the way, poor people can line up as well as rich people. And you limit the amount purchased–ration.

The notion that high prices will motivate rich people to conserve much is implausible.

I do understand basic economics. I would think having prices rise substantially from normal levels would be a sensible compromise. Further, limiting the extent of the emergency area and the length of time is essential.

And I don’t think “no gouging” laws are essential at all. I don’t think it is that hard to shift focus a bit to hauling in “free” water supplies for poor people who cannot afford the sky high prices.

Also, for the ignorant, price gouging rules are not something invented by FEMA in recent times. They are long standing local emergency powers. The notion that FEMA should rationally plan all recovery effots is separate from the issue as to whether local governments can prevent “price gouging.”

If it were me, (and it maybe me,) I would be arguing that keeping prices the same as there were in “normal” conditions is a big mistake, and that somewhat higher prices are fully justified due to the higher costs of operations during the emergency and the need to provide an extra reward for bring emergency supplies into the area. This is parellel with the distriubtion of free goods, and at least part of the goal is to return to normal conditions.

Water is ultimately a public resource which nobody produces originally. Hence no one is robbed if the government collects the profits on its sale and distributes them as it sees fit, perhaps to the poor people in need of water. (Assuming of course that in the absence of fundamental individual claims, government is the agent with the best claim on society’s resources.)

“Since the very wealthy consume such a low percentage of their income, I don’t see how you can have a consumption tax as progressive as an income tax.”

I should do a post on this fallacy, but Steve Landsburg already did. You can’t get blood from a stone, and you can’t extract taxes from someone who doesn’t consume much. Rather the taxes come from elsewhere, either the investments he would have made, or the charities he would have given money to, or his heirs. Obviously a consumption tax hits lazy heirs quite hard (compared to an income tax.)

Bill, I don’t see where you’ve addressed my argument. I say that total utility is higher if water is allocated on willingness to pay, not randomly by first come first served. Suppose we did have laws against price gouging, and we rely on long lines. Would you favor allowing those waiting in line to sell their position to the highest bidder? If not, why not? If so, then we have a market, except you are given the profits to the lucky people first in line, not the store. What does that gain?

“Water is ultimately a public resource which nobody produces originally.”

That depends greatly on what you mean by ‘water’. Usually in these debates, people assume they’re talking about safely drinkable water. Here in Scotland, there’s an abundance of natural water, but your innards will start to be very funny if you drink it indiscriminately. Collecting, storing, protecting, purifying and distributing water all require production.

Brian, read Chamley-Judd. It turns out that labor-taxation already imposes a distortion on the capital market, along with everything else that is bought with labor income; and then capital taxation imposes a second-distortion on top of the first.

Of course the difficulty in grasping this goes back to the Marxian fallacy that under capitalism labor and capital belong to two different classes of people.

“W.Peden, that’s why I said “ultimately”. Undrinkable water is the key input in making drinkable water.”

Sure, but if it’s not the ONLY input, then those producing the output would be robbed if their profits were denied to them.

“I am assuming your last line was a joke.”

Not at all. Water falling from the sky is the first part of the process of producing drinking water (and it will do for some purposes e.g. watering flowers, filling ponds or washing a stain off a jacket) but it’s not drinking water, which is what people make profits (and losses) from.

(All that’s presupposing, for the sake of argument, the very dubious premise that profiting from output that has a singular input is different from any other kind of profit. If there was a model whose good looks were entirely natural, would they be wrong to earn money by selling those looks? Would such earnings be relevantly different from normal mortals who have to spend time and money getting to the point where they look like a model, even with natural talent?)

W.Peden, I meant collecting the rent on the unimproved value of original water supplies, like mining royalties, or the Georgist land tax.

It’s not just that water is unproduced. Someone born with good looks does not deprive others of those good looks. Someone growing crops with land and seed that is agreed to be his, does not deprive others of those crops. But I have always objected to the “finders-keepers” method of original appropriation. The Lockean proviso never really held with large populations.

Even a rentier must select who will pay the rent. What’s the distinction between renting out money and renting out water?

As for “deprivation”, owners of water only deprive others of that water if we presuppose that water ownership is relevantly different from other kinds of ownership. However, isn’t that precisely what is at issue?

Negation, It makes no sense to mix cyclical issues with long run public finance questions. So I strongly disagree with the DeLong quotation you produced. Decisions about tax policy should take the path of NGDP as a given, it is much too hard to figure out the long run impact (if any) of tax changes on NGDP.

Saturos, You are probably right about Lacker.

W. Peden. I’ll have to remember that “water doesn’t just drop from the sky” line.

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Welcome to a new blog on the endlessly perplexing problem of monetary policy. You’ll quickly notice that I am not a natural blogger, yet I feel compelled by recent events to give it a shot. Read more...

Bio

My name is Scott Sumner and I have taught economics at Bentley University for the past 27 years. I earned a BA in economics at Wisconsin and a PhD at Chicago. My research has been in the field of monetary economics, particularly the role of the gold standard in the Great Depression. I had just begun research on the relationship between cultural values and neoliberal reforms, when I got pulled back into monetary economics by the current crisis.